Virtual currency or virtual money has been described as “a kind of unregulated, digital money, issued and normally managed by its developers, and used and accepted between the members of a specific virtual community.” Bitcoin is one of the more popular virtual currencies. Bitcoin, thanks to the absence of a central authority, provides a reduction in transactional costs. Even so, it can reduce both time and fees to transfer money. In some cases, there might be transactional fees to get a more rapid process. The chargeable transactions, paying higher fees compared with the others, most likely have preferences during validation. Bitcoin makes use of cryptography and digital signatures as security measures, making it almost impossible to alter maliciously the public ledger. Combined, these features generate an environment that recreates most of the key characteristics of a cash transaction.
The impact of Bitcoin is not limited to digital money. There is additionally a key innovation with the blockchain protocol. This solution can generate and establish technically trust among participants as never seen before. In a world where money and profits always occupy primary roles, this concept is potentially game-changing.
As of mid-June 2016, the value of all blockchain-based currencies in circulation was $14.37 billion, and the price of Bitcoin was, as it has been historically, a leading driver of this growth. At June 2016 highs of $700, the price of Bitcoin had risen by almost $300 since the end of May 2016. Today Bitcoin is trading at $7500.
Christine Lagarde, Managing Director of the International Monetary Fund (IMF), in an interview for the World Economic Forum (2015), has drawn attention to both the positive and negative impacts that such innovation could bring about. The impacts are not only in reducing costs but also in providing better value and reaching the unbanked. There is a positive impact on reducing the influence of the size of the shadow-banking system. Negative impacts may have disrupting consequences, and not only for monetary policies. The points of strength might turn out to be a double-edged sword: the combination of trust and anonymity could properly fit the aims and the requirements of crime. Crime might benefit from a digital environment able “to recreate most of the key characteristics of a cash transaction”.
On the other hand, Bitcoin and blockchains may become tools used for illicit transactions, money laundering, tax evasion and a potential threat to financial stability, being completely outside of a regulated environment.
Virtual currencies, and in particular Bitcoins, are indeed pseudo-anonymous (IMF 2016). Even though transactions are publicly recorded in the ledger, it is almost impossible to trace back the user’s virtual identities to the user’s real-world ones. As a consequence, regulatory and policy challenges are most likely the biggest issue for virtual currency holders.
Several international bodies have both provided a forum to discuss issues related to virtual currencies and contributed to the debate through the issuance of reports, guidance and manuals in their areas of expertise. In particular, the Financial Action Task Force (FATF)—the Anti-Money Laundering (AML)/Combating the Financing of Terrorism (CFT) standard-setter—and the United Nations Office on Drugs and Crime (UNODC) have focused on the prevention and law enforcement response to the money laundering risks posed by virtual currencies. The Committee on Payments and Market Infrastructures (CPMI) has considered the implications of virtual currencies as a means of exchange and distributed ledger technologies for central banks. Other institutions that have contributed to the debate include the Organisation for Economic Co-operation and Development (OECD), the European Banking Authority (EBA), and the Commonwealth Secretariat.
Customer protection is a challenge of virtual currencies. Customers are particularly vulnerable in the virtual currency’s environment. In the worst possible scenario (a disruption in the virtual currency protocol), the entire system would be paralyzed with a high probability of losses between virtual currency holders. Fraudulent operations, together with the overall absence of regulation, make the customer more vulnerable. It is possible to steal virtual currencies through hacking tools and fraudulent investment schemes. It is not only a matter of crime but also illicit transactions. It is unclear in the case of a dispute: which national agency should regulate it. Currently, a lot of disparity and inconsistencies exist between jurisdictions, making coordination far more difficult. Traditional regulatory models may not apply to the virtual currency decentralized systems.
The irreversibility of transactions is another big issue. Users, in the case of problems, do not have the right to reverse the charges.
The last issue relates to monetary policy. It covers governments’ and central banks’ activities. Due to the relatively low amount of cryptocurrencies in the monetary system, they do not represent a problem. If they become more widely used, they start to create concern in the public institutions in charge of managing monetary policies.
Virtual Currency and Fintech
The research developed in 2015 by H2 Ventures, KPMG, and Matchi (2016) may be instrumental in understanding how leading fintech companies are leveraging on blockchains and in particular on Bitcoins in their business.